(Tremblant Capital Group) Behavioral Finance Question 1: Should the fund continue to invest into the company?

Please justify your answer with financial analysis of the company.

Based on the data available for GMCR, following details are observed. Past Performance: In last 5 years. Revenue for the company has grown with a CAGR of 33.5%, while net income has grown with a CAGR of 28.8%. (Corresponding figures for the competitor are 20 % and 12.7% respectively. EPS has also grown steadily over the last 5 years form $0.2 to $0.6. P/E ratio has also consistently remained on higher side (>40). In the last 5 years, the share price for the company has grown strongly with a CAGR of 43%. While the growth in share price for the competitor has remained relatively weak at a CAGR of 13%. Average Year on Year sales growth for Tremblant has been close to 40% (compared to competitors year on year growth rate of 20%). Future projection: As seen in the below chart, the tipping point for the brewer sales is seen in the year 2008 indicating the adoption of the technology by the consumers. Tipping point is also driven by the increasing use of K-cups in 2008 well supported by network effect of increasing adoption of brewers.
Sales figure for Brewers (actual & projected)
1400 Brewer Sales (1000 units) 1200 1000 800 600 400 200 0 Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec06 07 07 07 07 08 08 08 08 09 09 09 09 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Tipping Point in 2008 At-Home Brewers Sold Away-from-Home Brewers Sold

Projected Figures

Time Line

(Tremblant Capital Group) Behavioral Finance GMCRs coffee business is also expected to do well despite being under threat from competitors and increasing coffee price. Driven by its strong past financial performance, healthy demand in the market and scope for wider penetration in the market, GMCR is expected to maintain its current growth rate. A simple growth model for future years (as shown below) estimates EPS of $0.91 in FY 2009, $1.25 in FY 2010, $1.69 in FY 2011, and $2.27 in FY 2012 against the Rabins projected values of $1.25 in FY 2009, $1.54 in FY 2010, $1.92 in FY 2011, and $2.48 in FY 2012. Table below shows the projected figures with simplified extrapolation of the past financial data.
Revenues COGS % of Revenue Selling, General & Admin Cost % of Revenue EBITDA % of Revenue Sep-09 700 408 58.3 199 28.4 93 13.3 Sep-10 980 579 59.0 274 28.0 127 13.0 Sep-11 1372 814 59.3 383 27.9 176 12.8 Sep-12 1921 1135 59.1 544 28.3 243 12.7

Risk factors GMCR debt/equity ratio has been close to 0.9 in last 3 years. As the GMCRs revenue and growth prospects are heavily dependent upon the success of its Keurig system so the current debt position may not be the optimal for an innovation based company. Keurig system is under threat from latest brewers with new technology. A stronger and better technology machine may cause the complete inversion of Keurig systems demand. Any measure to counter this threat (through investment in R&D) is not visible at GMCR. The soundness of the market channels to handle very high sales as projected is under question. As consumer products are highly susceptible to the availability and visibility in the market. It is a key parameter (and challenge) to maintain the same amount of availability and visibility in the market. Summary of GMCRs profiling Parameter Indicators Score Negative Positive Past Financial EPS, Revenue & profit Performance CAGR Current Debt/Equity (Financial Standing/Future health), Management Projections Team, New market penetration /Growth (opportunities) Risk Factors Competitors , Saturated

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(Tremblant Capital Group) Behavioral Finance Market channels , Technology (Threat) Overall

Above analysis indicates that company should continue to invest long in GMCR while carefully looking at the risk factors. The S&P 500 is going down so the reaction of the GMCR stocks in the fall 2008 may be due to cumulative market effect. GMCR is only representative from its industry in Tremblants portfolio, so it is important to maintain a healthy poison in GMCR to keep the diversity. Question 2: Elaborate the investment decision in Question 1 with respect to behavioral finance patterns (at least 3 behaviors)

The investment decision above is based on the financial performance of GMCR as well as the related future projections. Following behavioral finance pattern might have influenced the decision to invest in the company. Representativeness heuristic The available financial data is used to establish the soundness of the company prospects. The data might have been interpreted to bring the favorable outcome. EPS, Net income, P/E etc have been analyzed for increasing trend in last 5 years. So, the growth in EPS, Net income is given more importance. Despite that fact actual earning follow a random walk, in line with behavioral finance biases, importance has been given to establish a steady trend in growth of key financial parameters. Due to fast, selective interpretation of the available information, the outcome can be narrow & weak than expected but the analysis takes into account that the present decline in the stock price which may be caused by recent news about the company ignoring the past financial performance. Recent fall in GMCRs share may be due to the immediate conclusion drawn from the insider stock selling by the GMCR chairman. Under reaction: In general people under react to information about short term prospects of the company such as earning forecast, stock price etc. Though there has been reports of poor performance of the stock, including the independent research report which graded GMCR poorly on its earning quality, the financial

(Tremblant Capital Group) Behavioral Finance newspaper barons articles about high stock prices of GMCR, selling of $5.7 million stock by GMCR chairman along with the reports about vulnerability of the Keurig brand and development of short seller interest in GMCR, still these facts were not given significant weightage when taking the above decision to maintain a long position in GMCR. The anomaly under reaction is exhibited due to investor overconfidence and biased self-attribution. Overconfidence/Optimism Self attribution contributes investor confidence in over estimating its ability to value stock and predict future prices. Confirming information in public arena encourages the investors but disconfirming information doesnt discourage them, which exactly is the case in the above scenario. Though we have some disconfirming information available in the public domain, still we dont pay heed to it while taking the decision. In general individuals are overly optimistic and overconfident about their abilities. In the given scenario, the above decision is also based on the fact that Tremblant has been better in evaluating a firms future prospects, irrespective of what the market thinks and have previously bought firms that have been perceived as overvalued by other investors. This shows the overconfident on Tremblants part. Also, in making this decision there has been more focus on potential returns and not on possible losses. Disposition Effect Disposition Effect explains the behavior of investor to keep past winners in their portfolio and sell past losers. It relates to the tendency of investors to sell shares whose prices have increased, while keeping the shares that have dropped in price. This is driven by the fact that Investors are less willing to recognize losses (which they would be forced to do if they sold shares which are falling in value) Tremblant established its position the company at stock prices >$20, so when the stock prices are below $20, the dispersion effect lead the investor to maintain its position. Same disposition effect is in fact causing the under reaction to the news related to accounting impropriety, insider stock sales etc. Moreover, it is also leads to overconfidence in investor in terms of biased self attribution anomaly, over estimating the skill to invest in a market and making the right choice. As per the disposition effect, it has been decided not to dilute the position GMCR instead it is being recommended to consider increasing the stake in the company thereby avoiding the recognition of losses.

(Tremblant Capital Group) Behavioral Finance

Confirmation bias Confirmation bias is a behavior in investors to favor information that confirms their preconceptions or hypotheses regardless of whether the information is true or not. It is again driven by the disposition effect where investor tends to keep the loosing shares. The investor would gather evidence selectively, and interpret it in a biased way to substantiate his position. Accordingly, various financial parameters have been interpreted in a way to prove that the GMCRs past financial performance out weighs the current stock price decline, hence the under reaction. Investment Anchoring Short interest in GMCR is increasing which is explained by the investors behavior of basing the investment decision on irrelevant figures and statistics which may not be truly important like an isolated event of insider stock selling. Investors invest in the stocks of companies that have fallen considerably in a very short amount of time thereby anchoring on a recent "high" that the stock has achieved. Thus, drop in price provides an opportunity to buy the stock at a discount. As it is clear that that there is no major changes in the business strategy/scope of GMCR which would otherwise cause the GMCR stock price to decline, it may be interpreted that the decline in stock price is temporary, hence a good opportunity to strengthen the position in the company. Basically, the position of the company is strong with its key revenue generating product reaching the tipping point.